INLAND REVENUE BOARD OF REVIEW DECISIONS
Case No. D104/89
Profits tax – bad debts in the form of deposits with a financial institution – whether
deductible from assessable profits.
Panel: William Turnbull (chairman), Francis Jerome Law and David A Morris.
Date of hearing: 21 December 1989.
Date of decision: 14 March 1990.
The taxpayer was a company incorporated in Hong Kong. The main source of
income of the taxpayer was rental income. The taxpayer maintained fixed deposits with
financial institutions. One of the financial institutions became insolvent and the taxpayer
suffered a substantial loss. The assessor did not allow the loss to be offset against the profits
of the taxpayer. The taxpayer submitted that the losses arose in the ordinary course of the
business of the taxpayer of money-lending. The Commissioner argued that the taxpayer was
not a money-lender.
Held:
The taxpayer lent money in the course of its business and was entitled to deduct the
loss from its taxable profits.
Appeal allowed.
[Editor’s note : The Commissioner of Inland Revenue has filed an appeal against
this decision.]
Cases referred to :
Litchfield v Dreyfus [1906] 1 KB 584
Shun Lee Investment Company Limited v CIR 1 HKTC 322
Wong Chi Wah for the Commissioner of Inland Revenue.
Chua See Hua of Ernst & Whinney for the taxpayer.
INLAND REVENUE BOARD OF REVIEW DECISIONS
Decision:
This is an appeal by a limited company against the refusal by the Commissioner
to allow the company to offset certain irrecoverable loans against its profits assessable to
tax.
The facts of the appeal are as follows:
1.
The Taxpayer was incorporated in Hong Kong in 1973.
2.
At all relevant times, the Taxpayer’s main sources of income were rental
income from the letting of properties and interest income from fixed deposits.
For many years prior to the year of assessment 1985/86 the Taxpayer had
placed money on deposit with various financial institutions in Hong Kong
which deposits were made, varied, uplifted and rolled over as the Taxpayer
from time to time thought fit. Over the years the Taxpayer placed money on
deposit with various financial institutions but unfortunately for the Taxpayer
most of its deposits were latterly with X Limited, a financial institution which
appears to have collapsed in or before the year of assessment 1983/84.
3.
In its profit and loss account for the year ended 29 February 1984, the Taxpayer
charged against its profit an amount of $12,655,594 described as ‘fixed
deposits with [X Limited] written off’. The Taxpayer did not claim this amount
as a deduction in its profits tax computation for the year of assessment 1983/84.
4.
The Taxpayer submitted a profits tax return for the year of assessment 1985/86
and its accounts for the year ended 28 February 1986. In its proposed profits
tax computation, the Taxpayer claimed a deduction of $12,013,916 being fixed
deposits with X Limited written off. The amount was computed as follows:
Fixed deposits with X Limited written off:
$
Balance outstanding
12,655,594
Less: Dividend received from X Limited
(in liquidation)
641,678
Total
The Taxpayer provided the following note to this claim:
$12,013,916
=========
INLAND REVENUE BOARD OF REVIEW DECISIONS
‘ Since 1973, a deposit account has been maintained with [X Limited]. A
balance of $12,655,594 was receivable on 18 January 1984, the date of
liquidation. The directors considered it prudent to write off provisionally
the amount of $12,655,594 as an extraordinary item in the accounts for
the year ended 29 February 1984. Being a provision, this amount was not
included in their profits tax return for 1983/84. Subsequently, a dividend
of $641,678.05 was received. The directors consider that the balance of
$12,013,916 should be written off. They assure you that should any
dividend be received in future, it will be accounted for in their returns.’
5.
The assessor did not agree that the amount $12,013,916 should be an allowable
deduction and assessed the Taxpayer accordingly.
6.
By letter dated 20 February 1987, the tax representative for the Taxpayer
objected to the assessment issued by the assessor on the ground that it was not
in accordance with the return submitted.
7.
In correspondence with the assessor, the tax representative provided the
following information in respect of the fixed deposits with X Limited:
The amount written off is made up of :
$
Hong Kong dollars deposits
930,223
US dollars deposits
11,725,371
Total
$12,655,594
=========
8.
In his determination dated 10 April 1989, the Commissioner confirmed the
assessment of the assessor.
9.
By letter dated 4 May 1989, the tax representative for the Taxpayer duly
appealed against the Commissioner’s determination.
At the hearing of the appeal, the Taxpayer was represented by its tax
representative. The representative submitted that the fixed deposits with X Limited were
bad debts in the ordinary course of the business of the Taxpayer which was money-lending.
She said that it was necessary to prove four elements to satisfy the Board of Review that the
moneys written off were tax deductible. She said that the debt must be a bad debt and this
was not disputed by the Commissioner. She said that the debt must be in respect of moneys
lent and submitted that this was clear from the facts of the case. She submitted that the
Taxpayer must have carried on the business of lending money and submitted that on the
INLAND REVENUE BOARD OF REVIEW DECISIONS
facts of the case, the Taxpayer was carrying on business of lending money. She drew
attention to the fact that interest income was a substantial percentage of the income of the
Taxpayer. She then said that the fourth element was to demonstrate that the money was lent
in the ordinary course of the Taxpayer’s business. She said that the money lost was not the
loss of a capital asset but was part of the circulating capital of the Taxpayer.
The representative for the Commissioner submitted that to be tax deductible,
bad debts must be debts in respect of money lent in the ordinary course of the business of
lending money within Hong Kong by a person who carries on that business. He cited the
wording of the first proviso to section 16(1)(d) of the Inland Revenue Ordinance. He went
on to address the Board at some length on the meaning of the business of money-lending and
drew the attention of the Board to the cases of Litchfield v Dreyfus [1906] 1 KB 584 and
Shun Lee Investment Company Limited v CIR 1 HKTC 322. He submitted that a distinction
should be drawn between investments made by a company and loans made by a company.
He referred to the Australian Income Tax Act and submitted that the Taxpayer in this case
did not carry on the business of money-lending because it placed money on deposit with
financial institutions and did not offer to lend money to the public at large. He submitted
that the activities of the Taxpayer did not constitute carrying on the business of
money-lending within the meaning of the first proviso to section 16(1)(d) of the Inland
Revenue Ordinance.
With due respect to the Commissioner, we are not able to agree with the
submissions made before us by his representative. The rules relating to bad debts are set out
in section 16(1)(d) of the Inland Revenue Ordinance. The relevant part of which reads as
follows:
‘ 16(1)(d)
Bad debts incurred in any trade, business or profession, proved to
the satisfaction of the assessor to have become bad during the basis
period for the year of assessment, and doubtful debts to the extent
that they are respectively estimated to the satisfaction of the
assessor to have become bad during the said basis period
notwithstanding that such bad or doubtful debts were due and
payable prior to the commencement of the said basis period:
Provided that –
(i)
deductions under this paragraph shall be limited to debts
which were included as a trading receipt in ascertaining the
profits, in respect of which the person claiming the
deduction is chargeable to tax under this Part, of the period
within which they arose, and debts in respect of money lent,
in the ordinary course of the business of the lending of
money within Hong Kong, by a person who carries on that
business;
INLAND REVENUE BOARD OF REVIEW DECISIONS
(ii)
all sums recovered during the said basis period on account
of amounts previously allowed in respect of bad or doubtful
debts shall for the purposes of this Ordinance be treated as
part of the profits of the trade, business or profession for that
basis period.’
We do not consider that the reference to carrying on the business of lending
money within Hong Kong refers to registered money-lenders only. It is not a pre-requisite to
being able to claim a debt as a bad debt that the Taxpayer should be a registered
money-lender. In our opinion, it is the clear intention of the Inland Revenue Ordinance to
allow the deduction of bad debts where a person has lent money, for example, as in the
present case, by placing it on deposit with financial institutions. The word ‘business’ has a
very wide meaning and this has often been argued by the Commissioner himself in previous
cases. The business of money-lending is not restricted to lending money to the public. A
person can carry on a business of money-lending by making funds available to banks and
other financial institutions by way of fixed deposits. In this case the Taxpayer earned
significant income for itself by placing moneys on deposit with various financial institutions
including X Limited. The nature of this business was for the Taxpayer to place money on
deposit in various sums, uplift the same, and to roll over some of it for various periods of
time. This constitutes carrying on the business of the lending of money.
In the present appeal the Taxpayer chose to lend its money to a financial
institution which became insolvent and as a result the Taxpayer lost a substantial sum of
money. The loss suffered by the Taxpayer is deductible against its profits in the same way as
any other loss incurred in the course of carrying on business. We reject a submission made
on behalf of the Commissioner that the Taxpayer ‘invested’ its money in fixed deposits
rather than lending its money. A person who places money on deposit with a financial
institution lends money to that institution. If a person was buying and selling or buying and
retaining certificates of deposit the position might be different but that is not what we have
in this case. On the facts before us it is clear that what the Taxpayer did was to lend money
as a business and not to invest capital.
For the reasons given, we allow this appeal and direct that the assessment
appealed against be remitted back to the Commissioner so that he may make the necessary
amendments thereto by allowing the losses claimed by the Taxpayer in full.